We have been advising Apple (AAPL) investors to realize profits as the new iPhone 5 was being launched. In our recent Apple update, we gave a sell rating to AAPL and forecasted that the stock will fall below $600. Our valuation gave a price target of $579 for 2013. Apple did miss earnings targets and the stock dipped below $600, as we had predicted. Those who are bullish on Apple are arguing that the stock has bottomed out and is trading at an ex-cash P/E of 8x. The calculations below show that the stock is still trading at around our new 2013 Price Target (PT) of $549 and, therefore, does not have a big upside. Our PT has gone down despite good iPhone 5 sales because Apple's margins have squeezed, as we expected. We are giving a hold rating for Apple until margins and sales numbers for the iPad Mini and news about a stock split come through.
Here is a summary of our previous targets on Apple:
- June 15: We gave a buy rating for Apple at $574. The stock was up approximately 100 points in a month.
- Aug 24: The stock was trading at $663. We gave a buy rating and expressed the view that the stock will not cross the $1000 mark until the iPhone 5 becomes a block buster.
- Aug 28: We were bullish on the Samsung vs. Apple verdict and maintained our buy rating at $674.
- Sep 3 and Sep 5: We recommended ways to make money from the iPhone 5 launch and maintained that although the stock has an upside, there is a lot of post-launch risk with the iPhone 5. Therefore, we recommended that investors should use options such as covered calls, puts, and covered strangles to hedge against this risk. We expected the stock price to go down after the launch from the prelaunch price of $670-$700. The stock is currently trading at around $540.
- Sep 12: We were bearish on iPhone 5 and criticized its lack of innovation. Our recommendation was to wait till a post-launch dip for taking a long position.
- Oct 2 & Oct 9: The stock was back from its high launch price to $660 and most analysts were calling it a golden entry point. We argued that P/E and other valuations were to remain low because analysts had ridiculously high earnings' estimates. Our article had recommended investors to take partial profits because our analysis showed that the stock could plummet further. In a week after that, the stock had fallen more than 30 points.
- Oct 24: In our most recent update on Apple, we maintained that the stock was trading at a premium to its sum of parts valuation. AAPL was trading at around $610 and we forecasted that Apple will miss its earnings' estimates and trade below $600. We gave a Price Target of $579 and the stock was trading at $580 on November 6.
The cannibalization of iPhone 4s sales due to the anticipation of the iPhone 5 was much lower than we had expected. The company managed to comfortably beat our iPhone sales numbers and reported sales of approximately 27 million. iPad sales were lower than our estimate of 14 million. The real take away from these earnings is that margins for Apple have shrunk considerably, as we had suspected. The Gross Margin decreased from 42.8% in the previous quarter to 40% in the quarter ended September. The margins for iPhone 4s were just shy of 58% and the numbers for the current quarter reflect that margins for iPhone 5 could be as low as 50%. The importance of these margins to Apple is significant because the iPhone is responsible for more than 50% of its total sales (according to 2012 figures).
The margins for iPad products should also be readjusted in the wake of the launch of the iPad Mini. The cheaper iPad would cannibalize the sales of its larger counterpart and also reduce margins due to its low price range. We believe the margins for the iPad series would be below 30% in the coming quarters i.e. 28%-30%. These margins had been in the range of 30%-35% previously.
We are expecting the following sales numbers for the iPhone and the iPad for the next year:
Based on these assumptions, we have calculated the new sum of parts valuation for Apple:
Average P/E Multiple
Peripherals & iTunes
Software, Service & Other Revenue
Cash Per Share
The calculations show that if we price each segment on the average multiple of similar companies, the Price Target for 2013 will turn out to be $549. The competitors of iPhone for our PE average are Nokia (NOK), Research in Motion (RIMM), Samsung, and so on. NOK and RIMM are valued on their 2014 forward P/E and can easily beat low expectations of the market with better results. Apple is currently trading at a forward P/E of 10x on 2014 earnings expectations. The reason Apple's forward P/E misleads investors is that the estimates used in the calculation of this P/E are usually too high. Therefore, we have used a sum of parts analysis to calculate Apple's current PT. To see details of our sum of parts analysis, please view our previous report on Apple.
According to reports, Apple's lawsuit against Google (GOOG) for patent infringement was thrown out the window, only hours before a trial was scheduled to begin. This lawsuit was very important for Apple in its bid to gain a strong position in its smartphone software war against Google's Android. Apple had claimed that Motorola's licensing practices were unfair. Last week, District Judge Barbara Crabb had raised her doubts over the legitimacy of this case, and on Monday, she dismissed the case. Another blow to Apple on the legal front is Samsung vs. Apple case going against Apple in the U.K. The case caused much embarrassment for the technology giant, which was asked by the U.K. court to apologize to Samsung (GM:SSNLF) for suing unnecessarily.
The dividend yield is attractive at 1.9%, but we believe that due to high-capital uncertainty Apple is not a good dividend play for the time being. If the price falls further or consolidates at these valuations as we expect, AAPL will become an attractive dividend play.
A lot of people believed that it would be hard to fill Steve Jobs' shoes and the recent developments have shown that such people may be right. The Apple Maps fiasco and iPhone 5's problems are some of our concerns regarding the post-Steve Jobs Apple. The rapid changes in the Mobile technology sector in the form of the Lumia 920 and Galaxy S3 are disconcerting, to say the least, for Apple. iPhone would be facing tough competition from S3 and Lumia in the holiday season. We still believe that the iPhone 5 will lead the market this year, but its shrinking margins have made us revise our Price Target for 2013. We believe the stock is trading very close to its 2013 PT and there is very little chance of an upside. We are still not bearish about the long-term prospects of Apple, but we believe that the response to the iPad Mini and its margins would be vital to future valuations of AAPL.
It is likely that the AAPL's stock price will consolidate around $550, until a strong catalyst forces it to move higher. Therefore, we are giving a hold rating on Apple until the margins and sales' figures of the iPad Mini come through.
Any stock split in the near future can have a positive impact on the stock, and can challenge our valuations.